WASHINGTON -- The California Pollution Control Financing Authority will save $6.4 million in bond authority under the private-activity volume cap, thanks to a recent Internal Revenue Service private-letter ruling that a bond lawyer says may have wide application in the municipal industry.
In 1992 and 1993 the authority obtained cap allocations for, and sold two issues with, a total face amount of $636.7 million. Now the IRS says the authority needed an allocation based only on the actual issue price, which was about $630.3 million because the bonds were sold at a discount.
The ruling allows the California authority to carry forward the difference of about $6.4 million and use it on other projects.
Although the IRS made the usual disclaimer that its conclusion applies only to the underlying case and should not be regarded as setting a precedent, the ruling is strong enough that it will have wide application, said Richard Chirls, a partner with Orrick, Herrington & Sutcliffe. The firm represents the authority and sought the ruling from the IRS.
"The language used by the IRS in its ruling is sufficiently clear and strong that the ruling will, as a practical matter, be relied upon by counsel for other transactions," Chirls said.
In issuing its ruling, the IRS was clarifying a vague section of the Tax Reform Act of 1986, which created the volume cap requirement. Under that provision, states are permitted to issue annually an "aggregate amount" of private-activity bonds equal to $50 per capita or $150 million, whichever is greater. The law, however, does not further explain the term "aggregate amount."
As standard practice, issuers had been interpreting the law to require that volume cap allocations be obtained for the face amount of an issue, even though an original issue discount would lower the amount received by the issuer. The IRS ruling says that, at least in the California case, that was not necessary.
In analyzing the law, the IRS cited a 1983 revenue ruling, 83-154, that applied to mortgage revenue bonds, which at the time were under their own separate volume cap.
The 1983 revenue ruling stated that "aggregate amount" referred to the issue price, "because the issue price, and not the face amount, represented the actual dollar amount the issuer would have available to provide financing for owner-occupied housing through the issuance of qualified mortgage bonds," the IRS said.
When examining the California case, the IRS found that "there is nothing in the legislative history [of the 1986 tax act] to indicate that the approach taken in Rev. Rul. 83-154 is no longer valid."
"We therefore conclude that the term 'aggregate amount' in [the 1986 volume cap law] should be interpreted to refer to the issue price of bonds," the IRS said.
The ruling is likely to help other issuers in two ways, Chirls said. For one, they will probably seek cap allocations for future issues based on the issue price of their bonds. Secondly, they may follow the California authority's lead and look back at previous discounted issues to see if they can recoup any volume cap authority that was lost because they had obtained allocations based on the face amounts of their issues.
"Other issuers may be able to obtain similiar treatment for carryforward of volume cap due to original-issue discount bonds sold in prior years," Chirls said.
The ruling may also spur issuers to make wider use of original-issue discounts when market conditions permit, Chirls said.
"This is an important benefit, since OID pricing may be used to enhance the marketability of bonds and thereby lower borrowing costs," he said.
The California authority plans to use the $6.4 million in bond authority it has saved for upcoming solid-waste recovery projects, said Nathan Brostrom, the authority's executive director.
Brostrom said the ruling may be a boon to issuers there because it will make discounted issues more attractive to them. "Most of our big utilities have voided using OIDs," Brostrom said. Now, because of the IRS ruling, "if the market favors OIDs they may be more inclined to use them."
In the case of bonds issued at a premium, Chirls said that to his knowledge issuers have already been using issue price to determine the amount of volume cap allocation needed, and that practice will presumably continue under this interpretation.